After the United Nations Secretary General Kofi Annan handed over authority to the new government, the newly-installed President Xanana Gusmao thanked the international community for its support in ending Indonesian rule.

Mr Gusmao, a former guerrilla leader, said that those present at the inauguration were witnesses to the desire of all people for independence and to the struggle against poverty in all its forms.

In what was described as an important sign of reconciliation to the visiting Indonesian President Megawati Sukarnoputri, Mr Gusmao spoke in Indonesian, as well as in English and Portuguese, the language of the formal colonial power.

"We warmly welcome your presence here among us, not only in your capacity as the head of state of the brotherly and neighbouring country... but also as a symbol of the democratic journey of the brotherly people of Indonesia," he told President Megawati.

Wearing a traditional Timorese scarf, the new president paid tribute to the "bravery" of former Indonesian President Habibie.

Mr Gusmao also thanked Australian Prime Minister John Howard and former President Bill Clinton - both of them present at the ceremony - for their support in East Timor's struggle for independence.

'Day of pride'

East Timor voted for independence from Indonesia in 1999, and the territory has been under UN administration ever since.

The new flag now flies over East Timor

"Independence! As a people, as a territory, as a nation! One body, one mind, one wish!" said President Gusmao as fireworks lit up the sky.

But he warned: "Our independence will have no value, if all the people in East Timor continue to live in poverty and continue to suffer all kinds of difficulties."

Former colonial power Portugal, whose president and prime minister were at the ceremony, pledged more money for the reconstruction of East Timor, which is Asia's poorest country.

Before the UN flag was lowered, Mr Annan said he was "proud of the partnership" between the UN and the people of East Timor.

"It's a day of pride for all of us," he said.

Worshippers

Earlier, hundreds of worshippers attended morning mass at the house of the Bishop of Dili, Carlos Belo.